Many municipal bonds are exempt from certain taxes, provided certain requirements (e.g., certain Internal Revenue Service (“IRS”) requirements) are met. If these requirements are not met (or cease to be met), a bond may lose its tax exempt status. Determining compliance with these IRS requirements requires the maintenance of certain information relating to the investment and expenditure of bond proceeds, performing certain calculations regarding such investment and expenditure at different times over the life of the bond, taking certain action depending on the results of the calculations (e.g., making certain filings), and/or other actions. Additionally, it is necessary to maintain certain documents to support the information used to make such calculations.
Due to the number and variety of municipal bonds outstanding and issued each year and the complexity of the regulations regarding municipal bonds, it is often difficult for issuers or obligors (persons who benefit from the tax-exempt status of the bonds and are obligated to make payments of principal and interest on the bonds) to meet all of these requirements. These difficulties are compounded by the application of these requirements throughout the life of the bond and for several years thereafter (typical bond maturities can run 30 years or longer) and the fact that the traditional role of bond professionals typically ends shortly after the bonds are initially sold to the public. To further complicate matters, some issuers regularly go to market with separate issuances of bonds, and some obligors, such as charitable organizations, receive benefits from many separate bond issuances. Each separate issuance of bonds has, typically, independent needs for information, documents, and computations. Thus, those issuers and obligors must further determine and track which records of information and/or documents relate to which bond issuances.
Certain requirements necessitate calculations at certain times over the life of the bond. If these calculations are not timely performed, issuers and obligors may face the prospect of remitting penalties, interest, or other amounts to the IRS in order to maintain the tax-exempt nature of the obligations. These and other factors, therefore, place significant burdens and risks on issuers and obligors who fail to maintain documents and monitor compliance.
Many other requirements are imposed on municipal bond issuers. For example, pursuant to Securities and Exchange Commission (“SEC”) Rule 15c2-12, issuers must agree to make certain secondary market disclosure filings (discussed herein). Failure to timely make filings under SEC Rule 15c2-12 can lead to adverse ramifications, including ramifications with respect to the secondary market for issued securities or bonds. Additionally, when an issuer seeks to issue a new bond, there will be a five year look back with respect to that issuer's compliance history with respect to SEC Rule 15c2-12. Failure to timely make SEC Rule 15c2-12 filings can adversely impact an issuers' ability to issue new bonds.
Other requirements may exist based on rules, regulations or other requirements from the SEC, IRS and/or other regulatory authorities (or other entities) that impact the need to maintain information and supporting documents, timely make calculations, make filings and/or take other actions. Historically, many of these tasks have been performed manually. Some limited portion of these tasks may be performed electronically. However, there is no integrated tool that enables all of these functions to be performed, and that enables each unique item of data to be entered only once but also be reused for various functions. Nor does a system exist that enables all of this and the ability to store documents for each bond issue, e.g., to support the necessary calculations.
To further explain certain Federal tax requirements, by way of example, the Internal Revenue Code (“Code”) and Income Tax Regulations exclude from gross income interest paid on certain municipal bonds. Tax-free bonds described by the Code and regulations can be classified into, generally, three separate categories: governmental bonds, qualified 501(c)(3) bonds, and other forms of private activity bonds. The Code and regulations provide a plethora of rules governing the issuance, investment and expenditure of tax-free bond proceeds, and the use of the bond financed facilities.
By way of example, certain limits exist on how bond proceeds may be invested. Some of these requirements are referred to as arbitrage yield and arbitrage rebate requirements (detailed herein). Certain limits also exist on the use and expenditure of bond proceeds. For example, certain limits exist on the use of proceeds of governmental and qualified 501(c)(3) bonds for private business use, on the use of such proceeds to fund private loans, and on the use of qualified 501(c)(3) bond proceeds to pay for the costs of issuing the bonds. These are just but a few examples. Many others exist.
In many cases municipal issuers and obligors are prohibited from earning and retaining arbitrage (e.g., earning and retaining the profit from investing lower-cost tax-exempt bond proceeds into higher-yielding taxable securities). Thus, an issuer is periodically required to determine the amount of arbitrage earnings on bond proceeds and in many instances, to remit arbitrage rebate to the U.S. Treasury. The amount of arbitrage required to be rebated to the U.S. Treasury is generally determined once every five years during the lifetime of a bond per the requirements in section 148(f) of the Internal Revenue Code and regulations issued thereunder.
As a further example of a restriction on the expenditure of bond proceeds found in the Code, to avoid the treatment of governmental obligations as private activity bonds and the loss of tax exempt status, issuers must, generally, reasonably expect to (and actually) use less than some percent (e.g., 5% or 10% depending on the type of financing) of the proceeds, over the life of the bond, for private business use. Private business use in excess of the permitted percent may cause the bonds to be treated as private activity bonds and, generally, as obligations paying taxable interest. The private business use tests are imposed by section 141 and 145 of the Code and discussed in regulations issued thereunder.
To further explain, compliance is generally tested over the life of the bonds. For instance, the private business use tests are calculated over the life of the bonds. Therefore, as an example, excessive private business use in one year may be blended with less than the maximum permitted private business use in another year. Thus, an issuer or obligor may test compliance by making calculations periodically over the life of the bonds. An issuer or obligor may wish to perform a private business use calculation on multiple occasions during the life of a bond to, for instance, confirm compliance for reporting or management purposes, determine whether an additional proposed private business use of bond proceeds will fit under the compliance threshold, determine the impact of potential or actual sales of bond financed properties to nonqualified private users, manage compliance with the private business use limitations through re-allocation of expenditures (as permitted within certain time constraints under Internal Revenue regulations), and/or for other purposes. Optionally, substitutions may be made if allowed amounts are exceeded. For example, projects may be removed from a bond issue. If removed, allocations may be used for the substitute projects.
Historically, the private use and private payment tests, among others, were tested only on the date of issue based on certain reasonable expectations of the issuer and obligor as to how they expected to spend the proceeds of its bonds. The traditional role of bond counsel has been to perform diligence to assure that the issuer's and obligor's reasonable expectations relating to private business use and payment, and other matters, are reasonable as of the date of issue, and to provide an opinion that interest paid on the bonds is excludable from gross income based on these expectations. Bond counsel's role traditionally ends shortly after the bonds are initially sold to the public and its opinion is issued.
Beginning in the 1980's, Congress began to impose restrictions on municipal financing based on the actual expenditure and investment of the bond proceeds after the date of issue. Until the 1990's, the IRS rarely reviewed the actual investment and expenditure of bond proceeds or the actual use of bond financed facilities. In the mid-90's, the IRS unveiled a new bond examination program, which has been strengthened considerably since it was unveiled. The IRS is now investing significant resources on examinations relating to the actual investment and expenditure of bond proceeds, and the actual use of the bond financed facilities.
Notwithstanding the imposition of additional post-issuance compliance requirements relating to the actual investment and expenditure of the bond proceeds and the actual use of bond financed facilities, as well as the more active role of the IRS, the roles of the various transaction participants have not significantly changed from their historical roles. Therefore, although certain post-issuance requirements are required to be calculated and documented throughout the life of the bond for the bonds to retain their tax-exempt status, bond counsel's role typically ends shortly after the bonds are initially sold to the public. The issuer and/or obligor are, therefore, typically left with the responsibility to insure all post-issuance compliance requirements are met. Thus, the need to collect and maintain information and documents for very long periods, which can be extremely costly and burdensome, and to perform calculations, which can be complicated, traditionally falls on the issuer of the bonds or the obligor who may be unsophisticated or ill-prepared to handle such matters. The lack of a comprehensive tool to facilitate this compliance exacerbates the problems.
In the case of an IRS or other audit of the bond financing (or other examination activity), the issuer or obligor may be requested to show that its investment and expenditure of bond proceeds, and its use of bond financed facilities, conforms with the provisions of the Code, regulations, and/or other laws, rules, or regulations from the date of issue of the bonds to the date of the examination (or examination period). By way of example, the IRS may request information to show that any private business use of bond proceeds is less than the maximum percentage permitted over the life of the bonds from the date of issuance to the date of the examination. To meet this request, among others, the issuer or obligor will have to retain records of information and/or documents relating to the investment and expenditure of bond proceeds, and the use of bond-financed facilities over the entire life of the bond, plus those additional years in which an examination could be instituted within the statutory limitations period applicable to bondholders, which is generally a period ending approximately three years after the last bond of the issuance is fully retired. Other periods may apply. The above example illustrates the synergies provided by the features and functions of the systems and methods of the invention in that the ability to retain crucial documents and perform complex calculations relating to those documents under any one of a number of different, sometimes shifting, and as of yet undetermined requests by a regulatory authority cannot be accomplished by any current system or combination thereof. Other synergies and advantages also exist.
The same Code and regulatory requirements discussed above that can threaten the tax-exempt status of a bond if not met may also be cited by the IRS in its challenge of an obligor's interest deduction relating to the interest paid on the bonds or, in the case of a charitable institution, to assert additional taxes relating to unrelated trade or business income. To avoid these sorts of results, the issuer and/or obligor will generally have to retain records of information and/or documents relating to the investment and expenditure of bond proceeds, as well as information and/or documents relating to the use of bond-financed facilities, for the entire life of the bond, plus those additional years in which an examination of the obligor's tax returns could be instituted.
Additional reasons exist to retain records of information and/or documents in a systematic manner. The IRS recently released a proposed revision of its Form 990, which included a proposed Schedule K, “Supplemental Information on Tax Exempt Bonds.” Schedule K requests charitable organizations, which are subject to certain reporting requirements and with outstanding tax-exempt bonds, to state, for the pertinent taxable year, the “highest percentage of the [tax-exempt financed] project that was subject to a management contract or research agreement,” and to report the “highest percentage” of nonqualified use of any project financed by tax-exempt bonds. To perform these calculations, obligors will need records of information and/or documents from both current and prior periods. By way of example, information and/or documents relating to the nonqualified, private business use of bond financed property for a current reporting cycle may, by necessity, include contracts executed or other information from prior periods.
IRS Revenue Procedure 97-22 (“Rev. Proc. 97-22”), 1997-1 C.B. 652, provides guidance to taxpayers that maintain books and information and/or documents by using an electronic storage system that either images their hardcopy books and records or transfers their computerized books and records to an electronic storage media. This guidance provides general requirements for electronic storage systems utilized by taxpayers in order for such stored information to constitute “records” within the meaning of the Internal Revenue Code. The results of certain calculations relating to post-issuance investment and expenditures of bond proceeds, and the use of bond financed properties, may be included in forms and other items filed with the IRS and may require secondary market disclosure. For example, the results of calculations relating to the investment of bond proceeds may be included on the Form 8038-T, “Arbitrage Rebate and Penalty in Lieu of Arbitrage Rebate,” when a payment of arbitrage rebate is remitted to the U.S. Treasury. The results of similar calculations may be included on the same form when “yield reduction payments” are remitted. By way of example, the results of calculations for all prior rebate payments may be included in the Form 8038-R, “Recovery of Overpayment Under Arbitrage Rebate Provisions.” The results of calculations relating to the expenditure of bond proceeds and the use of bond financed facilities may be reported on the proposed Form 990, Schedule K. The results of certain tax calculations may indicate a need to post a material event as a secondary market disclosure (e.g., if such calculations show that the tax-exempt status of a bond is in jeopardy). These secondary market disclosure requirements typically arise as a result of SEC Rule 15c2-12.
Thus, some of the problems that issuers and obligors face in complying with post-issuance compliance requirements include: knowing and remembering when to make certain calculations; knowing all events or other facts (e.g., expenditures) that are relevant to the calculations; knowing the time limits applicable to the allocation of bond proceeds to expenditures; understanding the legal implications of certain post-issuance events; collecting, organizing and maintaining documents to support the calculations and allocations in compliance with post-issuance filing and other requirements; maintaining all such records of information and/or documents and/or calculations in a long-term storage system; making filings (IRS, SEC, and/or other filings), and/or taking other necessary or desirable actions. Additionally, when records are organized or maintained electronically, issuers and obligors may need to fulfill the minimum requirements relating to the proper storage of such records as determined by federal procedures, such as those specified in Rev. Proc. 97-22.
Various other post-issuance compliance obligations are imposed on issuers as well. For example, SEC Rule 15c2-12 mandates, in part, that brokers and dealers transacting in municipal bonds have reliable access to material information concerning the bond issuer's financial condition and/or ability to repair bond obligations. This necessitates that bond issuers (or their agents) make certain disclosures over the lifetime of the bond. For example, the issuer must make certain periodic filings (e.g., annual) and must disclose certain material events as they occur.
A limited number of tools exist to facilitate issuers' compliance with Rule 15c2-12. A leading tool to facilitate compliance with this rule is offered by Digital Assurance Certification LLC (“DAC”), the assignee of this patent application. That tool is an internet-based system that offers many features to facilitate compliance with Rule (the “DAC System”). Additional information relating to aspects of the DAC system may be found, for example, in U.S. Pat. No. 7,155,408 (“the '408 patent”), entitled “Method and Apparatus for Managing information and Communications Related to Municipal Bonds and Other Securities,” which is assigned to DAC and is hereby incorporated herein by reference in its entirety. The DAC system facilitates compliance with Rule 15c2-12. However, it was not originally designed to fully enable issuers to facilitate compliance and documentation of compliance with certain other post-issuance requirements.
Another challenge facing issuers relates to regulations that relate to certain funds, such as those addressed in SEC Rule 2a-7, 17 C.F.R. §270.2a-7, (“Rule 2a-7”). Rule 2a-7 regulates money market funds and specifies the characteristics of investments to be purchased and held by money market funds. Regulating funds that may invest in issues that are unregulated has the effect of indirectly regulating the issues, as an issue may not be able to attract investors unless it enables potential investors to comply with the relevant regulations (e.g., Rule 2a-7).
Some of the information needed to comply with Rule 2a-7 is generally not publicly available and some of the interested parties want to minimize certain types of information that becomes public (e.g. terms of guarantees, etc). Thus, the original DAC system, which was designed primarily to comply with SEC Rule 15c2-12 and to make such information available to the public, did not provide all of the information needed for funds governed by Rule 2a-7 (e.g., information that could not and/or should not be disseminated generally to the public) related to specific issuers and/or securities or bonds. Nor did it provide a tool to enable issuers to easily deal with this. Accordingly, in its original configuration, the DAC system would, in some instances, notify funds regulated by Rule 2a-7 that an event of interest had occurred with respect to a security or bond (e.g., the substitution of an insurer or guarantor, as is discussed herein), but did not enable these funds to securely and conveniently access all of the information that would dictate whether the event of interest would necessitate a liquidation, and/or prevent the purchase, of the corresponding security or bond.
DAC has recently introduced a tool, as part of the DAC system, to help address this challenge. Various aspects of this tool are described in U.S. patent application Ser. No. 11/669,642, filed Jan. 31, 2007, entitled, “System and Method for Managing Information Related to Securities and Securities Issuers,” which is assigned to DAC and is hereby incorporated herein by reference in its entirety. For example, this tool can enable filing of supplemental disclosures that include information that enables financial institutions managing money market funds to meet the requirements of Rule 2a-7, where at least some of the supplemental disclosures are subject to restricted access. The restricted access may be granted only to those limited number of entities who need such information (e.g., money market funds). The restricted access features provided by the system disclosed herein may facilitate ownership of bond issues (e.g., regulated by Rule 2a-7) by investors that, otherwise, may be unable to own the securities, due to the inefficiency, costliness, etc. of obtaining information and documents for bond issues (which the disclosed system herein provides via restricted access).
Although existing tools, including the DAC system, have addressed some aspects of the challenges facing issuers, various other challenges (including various post-issuance compliance and record retention requirements described above, and others) have not been adequately addressed by tools that existed prior to the invention. Additionally, while various ways of storing documents electronically exist, these electronic storage tools are often stand-alone applications. This presents various difficulties when trying to efficiently comply with the various requirements imposed on issuers. Discrete systems often require re-entry of the same information. This can be time-consuming and error prone. Additionally, in some circumstances, even if the discrete tools could perform various function described herein, it would be necessary to switch back and forth between different applications to comply with both SEC and IRS requirements. These and other drawbacks exist with existing tools.